Using a qualified pension or retirement plan as a means of giving to a "non-profit organization is often overlooked. You may just solve some of your estate planning problems by rolling over the proceeds of a lump-sum distribution from a qualified plan into a charitable remainder trust.
You have labored for many years to accumulate the money in your qualified retirement plan and probably the last thing on your mind is giving it away to a charity. Your plans likely include retiring at some time in the future or maybe you are already retired. You have been looking forward to receiving the income stream from the qualified plan you earned through your hard work. You are
presumably planning on leaving the assets in your plan to your children or other heirs.
An Unpleasant Surprise
You may not, however, be aware that you have a $0 tax-basis in your plan assets. Those assets have never been taxed. You were entitled to contribute to the plan with pre-tax dollars and defer those taxes until later when you start to receive your income stream. In addition, a qualified plan does not receive a step-up in basis at death. These types of assets are referred to as IRD (Income in Respect to a Decedent) assets. The effect of taxes on IRD assets can be devastating.
Death and Taxes
Without going into great detail, there are four separate federal taxes that may be levied on your retirement plan at death, resulting in total taxes nearly equal to (i.e. gross amount of the
qualified plan! They are the: 1) excess retirement accumulations tax, 2) net regular federal estate tax, 3) generation -skipping transfer tax and 4) Federal income tax. In addition, there may be a state death tax, which is equal to the federal credit for state death taxes paid. Some states may subject the plan to state and local income tax if your heirs reside in a state that imposes such taxes. However, there is a better way to conduct your affairs if your goal is to leave more assets to your heirs and benefit your favorite charities.
Planning Idea
Based upon comprehensive estate planning by qualified counsel, it may be prudent to take a lump-sum distribution, minimize current income taxes with 5-year averaging and roll over the rest (keep out enough to cover taxes) into a charitable remainder trust (CRT). With this plan, you could offset some of the current income taxes with the charitable deduction produced from the contribution into the CRT.
The amount in the CRT is now out of your estate. This will eliminate most of the taxes discussed above (other than the current income taxes). The qualified plan can now be replaced in your estate utilizing an irrevocable life insurance trust funded with life insurance. This keeps the insurance proceeds out of your estate and passes them on to your heirs income, gift and estate lax-free.
Case Study
To give you an idea of what all this might mean in an actual estate, review the chart on the following page. This will give you a feeling for the magnitude of the potential dollar amounts involved. Dollar amounts were computed with conservative assumptions and rounded to the nearest $100.
In Conclusion
IRD is probably the best kept secret of the federal and state governments. Do no planning and you have made the decision to pass on almost all of your IRD assets in taxes. It may not be possible to eliminate the impact of IRD taxes in all cases but this plan may very well help you to achieve your goals and objectives. In all cases you should seek competent legal and accounting counsel to achieve the best results in your planning.
Author Paul W. Gillis Jr., currently director of gift planning for Children's Hospital of Orange County, CA, is a founding partner of Planned Gift Associates, a planned-giving and consulting firm.
